## **Learning Outcomes**

This article explains how the CFA Institute Standards of Professional Conduct govern conflicts of interest and priority of transactions in a portfolio management setting for the CFA Level 3 exam. It focuses on identifying actual, potential, and perceived conflicts between client, firm, and employee interests, and on interpreting the requirement that client transactions must take precedence over firm and personal trades. The discussion clarifies what constitutes front‑running, inappropriate trade allocation, and other practices that breach the duty of loyalty, while contrasting them with acceptable personal trading under robust pre‑clearance and monitoring procedures. It details how fair dealing should guide the allocation of IPOs, block trades, and other limited investment opportunities among eligible client accounts using a documented allocation policy. The article also examines the role of written disclosure in managing conflicts, highlighting when disclosure is sufficient and when conflicts must instead be avoided or eliminated. Finally, it links these principles to typical CFA exam scenarios, reinforcing how to evaluate fact patterns, spot violations, and select compliant courses of action in a time‑pressured test environment.

## **CFA Level 3 Syllabus**

For the CFA Level 3 exam, you are expected to understand how the CFA Institute Standards of Professional Conduct apply in the portfolio management context—especially around transaction priority, conflicts of interest, and fair dealing, with a focus on the following syllabus points:

- Apply CFA Standards to identify and resolve conflicts of interest in investment management
- Explain the requirement that client investment transactions must take precedence over those for firm and personal accounts
- Discuss policies and procedures for allocation of investment opportunities and personal trading
- Evaluate case scenarios involving potential breaches of client priority and guidelines for disclosure

## **Test Your Knowledge**

_Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision._

1. What is the required order of priority for transactions in managed accounts, firm accounts, and employee accounts under the CFA Standards?
2. When may a portfolio manager participate in a personal trade if clients have expressed interest in the same investment?
3. Why must conflicts of interest be fully disclosed in writing, and to whom?
4. What is considered a breach of the CFA Standards when allocating limited investment opportunities?

## **Introduction**

Conflicts of interest in portfolio management can undermine both individual client outcomes and the reputation of the investment profession. The CFA Institute Standards of Professional Conduct set out clear rules protecting client interests and market integrity, notably regarding priority of transactions and fair dealing. This article explains how those Standards must be applied whenever personal or firm interests compete with client interests in managing investment portfolios.

## Conflicts of Interest in Portfolio Management

Investment professionals frequently face situations where their own interests or those of their firm could conflict with client interests. These conflicts can be actual, potential, or merely perceived—and failing to address them risks serious CFA Code violations.

> **Key Term: conflict of interest**
> A situation where an investment professional's duty to the client, or the ability to render objective advice, is impaired (or could appear impaired) by personal, financial, or firm incentives.

Investment firms must ensure that all actual or potential conflicts are promptly and fully disclosed in writing to clients and, where appropriate, to regulators. The preferred approach is to eliminate, or at least effectively manage, these conflicts through robust policies and procedures.

> **Key Term: disclosure**
> The written communication of all material facts relevant to an actual or potential conflict, so that a client or employer may make informed decisions.

Investment professionals must also avoid practices that create the appearance of impropriety, even in absence of an actual conflict.

### **Worked Example 1.1**

**Scenario:**  
An analyst discovers a lucrative investment opportunity relevant for several clients. Before recommending it, the analyst arranges to buy the security for her own account.

> **Answer:**  
> This violates the client priority of transactions. CFA Standards require all client trades to be executed before any personal trade. Personal benefit from information intended for clients constitutes a clear breach.

## Priority of Transactions: The Client Comes First

CFA Institute clearly states that investment transactions for client accounts must have absolute priority over transactions for firm accounts and personal accounts of investment professionals. This protects clients from front-running, cherry-picking, and other unfair practices.

> **Key Term: priority of transactions**
> The ethical and professional obligation to execute client transactions ahead of the personal or firm accounts of investment professionals.

This means that, if you wish to trade a security for your personal account, you may do so only after clients have been given full and fair opportunity to act on recommendations. The only exceptions apply to non-client-related trades (such as the purchasing of shares through an automatic payroll deduction plan or mutual fund reinvestments).

> **Key Term: front-running**
> The unethical practice of trading for one's own account (or an affiliated account) ahead of client trades, to take advantage of material nonpublic information or expected market moves.

### **Worked Example 1.2**

**Scenario:**  
A manager recommends a small-cap stock to all clients. He then purchases a large personal position before executing client orders, expecting the purchase to drive up prices.

> **Answer:**  
> This is front-running. It is a direct breach of the priority of transactions standard.

## Investment Allocation and Fair Dealing

All clients for whom an investment is suitable must be given a fair and equitable chance to participate in new or limited investment opportunities. Allocations should be based on a documented, pre-established policy considering investment suitability and account objectives.

> **Key Term: fair dealing**
> The obligation to treat all clients and prospective clients equitably in terms of investment opportunities, communications, and trade allocations.

Allocations cannot favor larger, more vocal, or more profitable clients over others. Any such favoritism constitutes a breach of the fairness requirement.

> **Key Term: allocation policy**
> The set of documented guidelines a firm uses to determine the fair distribution of investment opportunities among eligible client accounts.

### **Worked Example 1.3**

**Scenario:**  
A high-net-worth client requests to receive the full allocation of shares in a popular IPO. The manager agrees and allocates none to other eligible accounts.

> **Answer:**  
> This breaches fair dealing and priority of transactions. All suitable accounts must be given equal opportunity based on the firm's allocation policy.

## Personal Trading: Policies and Pre-clearance

Investment personnel must follow strict procedures for personal trading, including:

- Pre-clearance for all personal trades
- Mandatory holding periods
- Restrictions on participation if client trades are pending
- Firm policies detailing how personal transactions are monitored

Policies should be tailored to the firm's business lines and risk profile, but all must:

- Prevent front-running and misuse of client information
- Reflect that personal gains must never come at the expense of clients

Any violations must be reported and remediated immediately.

## Disclosure and Compliance Procedures

All actual and potential conflicts, including gifts, business relationships, and family interests, must be fully disclosed in writing to clients, employers, and regulators as appropriate. Compliance programs should include:

- Detailed codes of ethics and conduct
- Documentation standards for trade allocations and personal trades
- Regular staff training and certification
- Oversight by compliance officers independent of trading functions

## Consequences of Breach

Violations of the priority of transactions or failure to address conflicts of interest can result in regulatory sanctions, loss of CFA designation, firm penalties, and significant reputational harm. Violations are often easily detected through trade surveillance and client complaints.

### **Exam Warning**

> **A frequent exam pitfall is assuming that disclosure alone is an adequate remedy whenever a conflict exists. Some conflicts must be avoided or eliminated—not simply disclosed. Review the CFA Standards and your firm's policies for required action.**

### **Revision Tip**

> _Always prioritize transparent, written disclosure for any situation with the appearance of divided loyalties. Document your compliance steps before and after trades._

## **Summary**

Portfolio managers must recognize and strictly address conflicts of interest, with client trades always having highest priority over personal and firm accounts. Suitability, full disclosure, and fair allocation are cornerstones of CFA Institute’s professional standards and client trust.

## **Key Point Checklist**

_This article has covered the following key knowledge points:_

- Conflicts of interest must be identified, managed, and fully disclosed
- Client investment trades always take precedence over firm and personal accounts
- Personal trades require pre-clearance, restrictions, and possible holding periods
- Fair dealing mandates equitable allocation of investment opportunities among clients
- Failure to address conflicts or breach priority rules can result in severe penalties and regulatory action

## **Key Terms and Concepts**

- conflict of interest
- disclosure
- priority of transactions
- front-running
- fair dealing
- allocation policy

Standards application in portfolio context - Conflicts of interest and priority of transactions